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The 6 Ways the Detroit Bankruptcy Trial Could Go

November 21, 2013

By Nathan Bomey and Brent Snavely

Judge Steven Rhodes' decision on whether to authorize Detroit's Chapter 9 bankruptcy -- which could come any day -- will mark a historic pivot point for a financially devastated city government. But experts say it's more complicated than a simple yes or no, and the nuances of his ruling will lay the legal groundwork for the city's fiscal and political future.

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Most experts agree Rhodes likely will allow Detroit's bankruptcy to proceed. He's made comments over the course of the bankruptcy case so far that illustrate he's aware Detroit is in the national spotlight, its residents are suffering from poor services and retirees who depend on pensions for their livelihood are in limbo as the city's financial crisis worsens.

"Because of the attention that's being focused on this case and because of the likelihood of an appeal, I would suspect he'll address all the arguments," said John Pottow, a University of Michigan bankruptcy law professor. "No one wants to get overturned in a high-profile case. He's going to do all his homework."

The criteria to enter Chapter 9 bankruptcy requires a city to prove it's insolvent, obtain the state's approval and prove it negotiated "in good faith" or that it became "impracticable" to do so.

If the case proceeds, the city will propose a "plan of adjustment" by Dec. 31 to cut its debt and restructure operations. If the case is dismissed, the city will be swarmed with lawsuits from creditors who have not been paid in recent months.

Among the potential scenarios to watch for when Rhodes makes his ruling:

1. Eligibility approved, but the fate of retiree pensions is left undecided.

The ultimate fate of pensions for Detroit's 23,500 retirees is among the most contentious issues, but Rhodes has signaled that it might be premature to decide how pension benefits are affected until the city proposes a plan that addresses how all creditors will be impacted.

Laura Beth Bartell, a bankruptcy law professor at Wayne State University, predicts Rhodes will shy away from offering any hints on pensions.

"People read all sorts of things into any remark a judge might make in an opinion," she said. "If he wants to send a signal, he can certainly put something in there to send a signal."

Expect a furious fight to continue over the next several months over whether the Michigan Constitution's contractual protection of pension benefits trumps federal bankruptcy law.

2. Eligibility approved because the city negotiated "in good faith" with its creditors and met the other legal criteria.

Few observers expect Rhodes to challenge the city's assertion of insolvency or Gov. Rick Snyder's decision to authorize the filing. But whether the city negotiated in good faith? That's a tougher call.

Rhodes tussled with Jones Day attorney Bruce Bennett's "good faith" argument. Rhodes said "it strikes me as factually impossible" to argue the city negotiated in good faith, and yet it was legally "impracticable" to do so.

"I think you absolutely can believe in your head this is never going to work -- but try anyway," Bennett said.

If Bennett managed to sway him, Rhodes could rule Detroit is eligible for bankruptcy because the city passed the "good faith" test.

3. Eligibility approved because, although the city failed to negotiate in good faith, it was nonetheless "impracticable" to do so.

The city's "good faith" argument suffered several blows during the trial. Creditors outlined, in painstaking detail, how the city rushed from its June 14 meeting to its July 18 bankruptcy filing with few substantive conversations.

"The governor took more time to interview the consultants" to restructure Detroit "than they took to negotiate the restructuring itself," said Sharon Levine, an attorney for the city's largest employee union, Michigan Council 25 of the American Federation of State, County and Municipal Employees, during the trial. "That's absurd."

But a legal path is still available for the city to qualify for bankruptcy even if Rhodes decides it failed to negotiate in good faith. By July 18, Detroit was being bombarded by lawsuits, including challenges to the legality of the emergency manager and a suit by bond insurer Syncora seeking to trap the city's critical casino revenue.

Also, the city has more than 100,000 creditors and argued during the trial that no one was truly representing the retirees at the bargaining table. Bennett argued all of those factors made it "impracticable" to continue trying to find an out-of-court solution.

Bartell predicts Rhodes will approve the bankruptcy with this reasoning.

4. Eligibility approved, and the state's emergency manager law is constitutional.

Several creditors have challenged the city's bankruptcy under the premise that the state's emergency manager law should be tossed out, invalidating Orr's appointment and overturning the bankruptcy.

Rhodes has questioned the way Lansing lawmakers quickly replaced the emergency manager law overturned by voters in November 2012 with a new version one month later that couldn't be uprooted at the ballot box.

But Rhodes also has taken steps to block legal challenges that could result in Orr's ouster.

5. Eligibility is approved, but immediate appeal is allowed.

Lawyers for AFSCME have already asked Rhodes to allow them to appeal his ruling directly to the 6th Circuit Court. If Rhodes agrees and the appeals court accepts the case, it would allow an appeal to bypass the U.S. District Court Eastern District of Michigan.

"When it's a very important matter and you really need to have a decision that's final, going quickly up to the Circuit Court makes sense," Bartell said.

Critically, the case will be allowed to proceed even if an appeal is filed -- and Pottow said it would be difficult for an appeal to succeed by challenging the facts of Detroit's finances and negotiations.

If he chooses this path, it's likely Rhodes will say the city didn't negotiate in good faith with its creditors.

If the case is dismissed, the city would be sucked into a litigation vortex and have no legal protection from creditors it has failed to pay. That would include pension debt holders who did not receive a $40-million payment in June and bondholders who didn't receive payments due in October.

The city would almost certainly be besieged by lawsuits, triggering an even deeper financial downward spiral that could lead right back into bankruptcy with even fewer assets to divvy up among creditors.

(c)2013 the Detroit Free Press

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The largest-ever municipal bankruptcy petition in U.S. history faces a watershed moment on Tuesday, as the judge overseeing Detroit's bankruptcy case is scheduled to rule whether the city is eligible for protection from creditors - an event that has citizens, public officials, creditors, retirees and others awaiting the judge's words and preparing responses.
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